But Chinese leader Xi Jinping rejects these accusations, saying: “There is no problem called Chinese excess production capacity.” Instead, Chinese officials say electric cars, solar panels and other Chinese products are simply better and more competitive than their Western counterparts.
But a look at the Chinese industrial sector shows clear signs and indications of the presence of surplus production capacity, especially in industries such as solar panels, cars, and steel. In some sectors, the situation looks set to worsen, as China continues to expand its production capacity even as domestic demand remains weak.
It is not easy to define “excess production capacity” because it is not clear what “excess” is meant by and what it is measured against.
Should the size of Chinese industry and new investments be compared to its current growth? For world growth? Or against China’s future growth?
Western politicians anticipating a wave of cheap goods prefer the first definition (i.e. comparing the size of Chinese industry and new investment with its current growth), while Beijing prefers the second or third definition.
What is clear is that since 2021, Chinese companies have invested more in manufacturing than usual, even though domestic demand and exports have often been weak.
This trend has been particularly noticeable for some sectors that enjoy Beijing’s support and often benefit from subsidies, such as electric vehicles.
Investment growth in the automobile sector reached about 25 percent year-on-year in early 2023. But the surge in investments in solar panels, electronic chips, and batteries is even more impressive.
Profit margins are shrinking…a new sign of excess production capacity
With the increase in investment volume, the profit margins of Chinese producers and manufacturers have decreased significantly, especially for automobiles and steel.
Net profit margins for the Chinese manufacturing sector as a whole were less than 4 percent in early 2024, well below the average of about 6 percent in the late 2000s.
Chinese exports are under pressure
Massive production capacity coupled with weak demand and low margins at home have pushed more Chinese goods into global markets. This oversupply has reduced the prices of some Chinese goods and undermined or weakened competitors abroad.
But the effect was different depending on the different products.
While Western politicians have focused on the threat from Chinese cars, the price decline has so far been much worse in the steel and solar panel sectors.
Lithium-ion battery prices have risen sharply since 2020 – although they have begun to decline rapidly recently.
The distressed real estate sector bears part of the blame
China’s recent overcapacity problem emerged in serious earnest around the same time that the country’s real estate sector experienced a major collapse. This is no coincidence.
The real estate collapse curbed demand for steel and other building materials.
As borrowing for mortgages dried up, the collapse also freed up excess savings to invest in things like cars, chips and solar cell factories — something strongly encouraged by Beijing, which favors a model of economic growth based on manufacturing rather than one based on real estate and consumption.
As long as China’s real estate market remains stagnant, Chinese individuals continue to save, and Beijing insists on getting out of economic problems through industrialization, China’s surplus capacity situation is unlikely to improve significantly.
The solar sector is in a worse position
China’s spare capacity situation looks even worse in solar cell manufacturing, which, along with other clean energy applications, is among the so-called “new productive forces” that Beijing is highlighting as a key element of its future growth strategy.
According to official data, in 2023 China produced more than 450 gigawatts of solar cells. But it has installed less than 220 gigawatts domestically – a huge number but still less than half of what it produces.
Capital Economics estimates that China will manufacture about 750 gigawatts this year. If installations remain at the same level, it will mean that China will produce about 500 gigawatts of “surplus” solar cells in 2024.
This is a very large number, enough to know that it is equivalent to almost four times the total number of solar panels installed in 2023 in the rest of the world.
The situation could get worse in steel and batteries
China is the largest producer and consumer of steel in the world. Its steel exports usually increase significantly when the real estate market faces problems.
But China still uses a higher proportion of its steel production domestically than at the height of the previous Great Recession in the real estate sector in 2015, and during the global financial crisis in 2009.
However, steel margins look much worse than in 2015, partly due to higher iron ore prices. This means that steel manufacturers have a strong incentive to find higher prices abroad.
For batteries, the global supply and demand balance looked better until recently. But there are now clear warning signs on the horizon.
Prices for Chinese lithium-ion battery exports have trended sharply lower since late 2023, as global automakers eased the pace of electric vehicle production.
Meanwhile, Chinese manufacturers are bracing for a historic surge in supply, despite recent guidelines from Beijing aimed at limiting investment in low-cost battery production.
Goldman Sachs estimated last year that China’s electric car battery production capacity would reach about 1,000 gigawatt hours by 2025 – nearly double the US bank’s forecast for Chinese demand.
Goldman Sachs also expects the utilization rates of battery factories outside China to decline from about 100 percent in 2022 to about 80 percent by 2026.
A glimmer of hope for Chinese cars
Political attention has focused on China’s growing auto exports and excess production capacity, and this is justified given how important the auto sector is to Western economies.
But while the situation for some Western automakers is undoubtedly very difficult, the wave of investment in the Chinese auto sector for 2022 and 2023 is now calming.
Investment, which was growing by nearly 20 percent year-on-year in 2023, has fallen to 5.7 percent, a figure roughly in line with the historical average. Profit margins also appear to have stabilized, albeit at a lower level than in the past.
In other words, while excess production capacity remains large, it may not grow so quickly anymore. China’s car price war and slowing electric vehicle adoption abroad appear to have finally put the brakes on the feverish investment mania at home.
However, profit margins in electrical equipment are trending down again – another warning sign for solar cells and other equipment such as batteries.
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